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India needs more than five million homes annually and more than 90% of this demand is in the affordable segment — homes priced at less than $50,000. But supply is lagging. Rajesh Krishnan, founder and CEO of the Brick Eagle Group, a financial services platform for affordable housing, says the disparity between supply and demand is because of a broken ecosystem. According to him, everybody in the affordable housing value chain “seems to be missing some piece of the puzzle.”

In a conversation with Knowledge@Wharton, Krishnan talks about his prescription for affordable housing in India. He points out that along with being a pressing social need, it is also a $100 billion market opportunity. “We are making investments across the value chain so that we can take it from start to finish.”

An edited transcript of the conversation follows.

Knowledge@Wharton: Your background is in banking. How did you get interested in affordable housing?

Knowledge@Wharton: We’ll come back to the returns, but before that could you tell us about the housing market in India and the need for affordable housing?

Krishnan: We have more than a billion people in India and everybody needs a roof over their head. There are various studies by McKinsey, Deutsche Bank, Monitor and others on this topic. I’m told that the demand for affordable housing is some five million units every year. Today we are short of 20 million homes and it’s a growing problem because of urbanization. The important point is that supply is minuscule; less than 10% of the demand. As a result, in a place like Mumbai, more than 50% of people live in slums and sub-standard accommodations.

Knowledge@Wharton: What is Brick Eagle’s strategy to fulfill part of this demand?

Krishnan: We realize that the people who want to do affordable housing typically lack access to capital. We started as a land banking company because we realized that what they usually need money for is to buy land. So, we started investing in land for affordable housing development. But we soon realized that the value chain for affordable housing is broken. And so we decided to invest in developers and service providers in this segment. Now we are looking to set up a housing finance company to fund home buyers. We are making investments across the value chain so that we’re able to take it from start to finish.

“The important point is that supply is minuscule; less than 10% of the demand.”

Knowledge@Wharton: You recently celebrated your fourth anniversary. Could you tell us about some of the major milestones and what you’ve been able to accomplish so far?

Knowledge@Wharton High School

Krishnan: At present we manage about 1,250 acres of land which, when fully developed, will house about 88,000 families. We are spread across three states — Maharashtra, Tamil Nadu and Gujarat and we have a team of 400 people. Last year, we delivered 1,100 houses and as a group we have developed about 4,000 homes so far. Now we are slowly ramping up. This year the target is to deliver 5,000 houses. But we hope to deliver more than 10,000 units a year within the next five years.

Knowledge@Wharton: Who would you say are your main competitors and how does your approach differ from theirs?

Krishnan: I don’t look at anybody as competition; I look at everybody out there as partners. You’ve got developers, private equity firms, construction technology companies and various other people. But everybody seems to be missing some piece of the puzzle. We want to plug those gaps and help these people deliver scale. For instance, we recently incubated a developer in Pune. They have access to funding and are very good at construction, but they don’t understand branding and distribution. So we put together the branding and distribution strategy for them. We recently also made an investment in a developer in Gujarat. They are very good developers and have won the award for the best affordable housing developer of the year. They have already delivered 3,000 houses but need capital to scale up. We told them: “You run operations and let us take care of finance for you.” We look at ourselves as a plug-and-play service to help others deliver scale.

Knowledge@Wharton: It seems to me that you are leveraging the housing ecosystem and your goal is to deliver houses priced around $5,000 to $10,000. Could you explain how leveraging the housing industries ecosystem and the technology ecosystem allows you to develop houses at these price points?

Krishnan: I would like to make a small distinction between affordable housing and what we call social housing. According to me, affordable housing is a market-based solution for housing the middle and low-income segments. Here, the trick is to make small format homes livable. Since this is a market-based solution, the per square foot rate is a market rate. The key value driver for affordability is size. So we put a lot of thought into making a 300 square feet home livable. The design, the interiors and all the amenities, etc. have a huge impact on the way the product is designed.

But the point that you are touching upon is what I would call social housing. Because when we say India needs 20 million homes at present, this demand is in the $5,000 to $15,000 price range. Here, you need a radically different approach because this segment is not very profitable. You need to come up with some kind of product, process or financial engineering to cater to this need. For instance, organizations like Habitat for Humanity are doing a wonderful job on the process engineering in terms of sourcing materials and labor at subsidized rates.

What we want to focus on is financial engineering. Today when we do affordable housing, our investors seek 3X return in five years. That’s about an annualized return of 25%. But if we can access capital from impact investors who are happy with 5% annualized returns, then we can use the benefit of the low cost of capital to subsidize housing for the poor. If we can get money at 5%, we can deliver houses at $5,000, $15,000 in scale in the outskirts of Bombay. That to me is magic.

Knowledge@Wharton: Who are your investors at present? Are they primarily impact investors and what is your pitch to them?

Krishnan: Till now we’ve been going to commercial investors. The pitch to them has been: “Let’s invest in land for affordable housing development. For you, it’s a fully secured investment that we’ll target at 3X return, while serving a pressing social need.” We’ve collected around $40 million on this pitch.

“We look at ourselves as a plug-and-play service to help others deliver scale.”

But now, what we are really excited about is doing social housing at the bottom of the pyramid. And for that we need to approach endowments, foundations, impact investors and others who are happy to accept a lower market return. We are not asking for charity. We’re saying you’ll make 5% return or 10%, if the need be. We got our first check for around $3.5 million from a family office in India to run a pilot project. We think there is a lot of money available from impact investors globally, especially from institutions, pension funds in Europe, banks, etc. who have allocations for social impact. We want to reach out to them this year.

Knowledge@Wharton: The flip side of any investment opportunity is the risk. What do you see as the primary risks of investing in affordable housing in India?

Krishnan: It’s India, so you can get hit from all directions. You just have to watch out. But I think it’s mainly idiosyncratic risks. People often ask me, “Hey, what about cost escalation? What if you’re not able to get material on time? What about construction technology?” To me, all of that is relevant. It can erode your profits but you will not lose your shirt.

Knowledge@Wharton: Those are all execution risks.

Krishnan: Correct. But most projects in India get stuck for two other reasons. It’s fair to say that a majority of projects in India are stuck because they run out of money. So, financial closure is very important. Ensure that you’re backing the right guy who has access to funding. The second would be just idiosyncratic risk. The legal framework in India is fragile. You just have to stay away from shareholder disputes, local disputes and keep it clean.

Knowledge@Wharton: Since you are aiming at social housing, have you made any efforts to reach out to organizations like Habitat for Humanity or social entrepreneurship foundations like Ashoka?

“If we can access capital from impact investors … then we can use the benefit of the low cost of capital to subsidize housing for the poor.”

Krishnan: Ashoka identified housing as a pressing social need in India about five years back and they’ve done phenomenal work. What they were doing was to aggregate demand at the grass roots level and encouraging developers to supply. But most developers were not interested in supplying at those price points. We met them and flipped the problem and said: “These are the areas where we can supply. Can you aggregate demand for us here so we can ensure that it goes to the most deserving beneficiaries.” We are now talking to them about partnering to set up a social housing fund. We are also speaking to Habitat for Humanity for a partnership because our goals are the same. We both want to enable a million homes in the next 15 to 20 years. They realize that with their current approach they may not be able to hit that number. If we combine forces there’s a good possibility we can make it happen.

Knowledge@Wharton: Where do you see yourself the next 10 years?

Krishnan: We have a two-pronged goal. On the one hand, we want to deliver 1% of India’s housing needs. That is around a million units in the next 20 years. It’s a herculean task and that’s our stated goal. On the other hand, all said and done we are a market player. McKinsey says affordable housing is a $100 billion market opportunity. And, as with every market, we think the top 10% to 20% of players will have 80% market share. We want one of our investee companies to be there in the top 10, in the next five to 10 years. Right now, as far as I can see, the field is wide open. There is no front runner. I think we have a decent shot at it.

Knowledge@Wharton: Based on your experience with affordable housing, what can developers of other affordable housing projects in different parts of the world learn from Brick Eagle?

Krishnan: That’s a difficult question. It’s a very local play, so one thing I would say is always have a local partner for every place that you go to. For instance, Homex, one of the biggest affordable housing developers in the world, came to India. They spent five years here but couldn’t launch a single project. While they of course know the game, there are huge local barriers to entry. So, recognize that you need to have local partners to execute. This has also been a reason why a lot of modern developers, corporate developers, in India have not managed to scale — because their decision making is very centralized. This is a very local game and you need to have a local person taking decisions on the fly. So, that would be one important learning. But, affordable housing is a global need so there are enough opportunities.

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2 Comments So Far

Ron Talati

Great article and nice try to attract an investor, however, there are many flaws in it.
1) 80-20 Doesn’t apply
Indian housing market consist many medium building construction groups, all of them holds fair share in their regions and therefore it would be hard to implement 80-20 ratio here. It’s more likely 65-35 ratio.

2) Interest Rate: 10.00%
The purchasing power of people is lot depend on interest rate and 10% is just too high. Average income is around 10,000 USD per year for many in the middle class, which makes them vulnerable to pay off their interest rate. Another issue is higher inflation 6-7% and the higher gap in income to mortgage ratio.

So the summary is housing in media is not affordable, to make it affordable only must reduce inflation, reduce interest rate and increase minimum wage standards. Let us focus on interest rate make below 5% will increase purchasing power, but that investor do not like that idea because it hurts their earning potential and ability to borrow money.

Anumakonda Jagadeesh

Outstanding.
The notion of housing affordability became widespread in the 1980s in Europe and North America. In the words of Alain Bertaud, of New York University and former principal planner at the World Bank,
“It is time for planners to abandon abstract objectives and to focus their efforts on two measurable outcomes that have always mattered since the growth of large cities during the 19th century’s industrial revolution: workers’ spatial mobility and housing affordability.”
Housing choice is a response to an extremely complex set of economic, social, and psychological impulses. For example, some households may choose to spend more on housing because they feel they can afford to, while others may not have a choice.

Lack of affordable housing places a particular burden on local economies.
As well, individual consumers are faced with mortgage arrears and excessive debt and therefore cut back on consumption. A combination of high housing costs and high debt levels contributes to a reduction in savings.
These factors can lead to decreased investment in sectors that are essential to the long-term growth of the economy.
Supply and demand
In some countries, the market has been unable to meet the growing demand to supply housing stock at affordable prices. Although demand for affordable housing, particularly rental housing that is affordable for low and middle income earners, has increased, the supply has not. Potential home buyers are forced to turn to the rental market, which is also under pressure. An inadequate supply of housing stock increases demand on the private and social rented sector, and in worse case scenarios, homelessness.
Some of the factors that affect the supply and demand of housing stock
• Demographic and behavioural factors
• Migration (to cities and potential employment)
• Increased life expectancy
• Building codes
• A greater propensity for people to live alone
• Young adults delaying forming their own household (in advanced economies).
• Exclusionary zoning
Factors that affect tenure choices (ex. owner occupier, private rented, social rented
• Employment rates
• Rising unemployment rates increase demand for market rentals, social housing and homelessness.
• Real household incomes
• Household incomes have not kept up with rising housing prices
• Affordability of rents and owner occupation
• Interest rates
• Availability of mortgages
• Levels of confidence in the economy and housing market
• Low confidence decreases demand for owner occupation(Wikipedia).

“At a rough estimate, India’s overall housing shortage as of today stands at about 22 million homes. Within this, the shortage of affordable housing – homes with price tags in the range of Rs. 10-20 lakh – accounts for a very sizable share. The supply of homes which people with less-than-spectacular financial resources but who still yearn to live in their own homes is still severely constrained.
Today, affordable housing projects near larger cities such as Mumbai, Pune, Bangalore, Delhi, etc. have benefited from institutional funding and have seen encouraging response from the buyer market. It is very encouraging to the affordable housing sector that many micro-finance companies have now come forward to help buyers from the economically weaker sections to buy homes in buying such homes.
Institutional funds can usually expect an internal rate of return (IRR) of approximately 25% by investing in residential projects. The IRR is even higher for well-located affordable housing projects because of the larger volumes and faster absorption. Additionally, they enjoy a higher degree of certainty in terms of the viability and success of such projects if they are dealing with developers of good market repute who have land holdings in the right locations.
Challenges
The primary challenge that institutional funds have been facing with India’s affordable housing sector is that many of the projects in this category are undertaken by small regional developers, with whom it is understandably difficult to partner in an amicable venture. Other areas of concern to institutional funds as well as investors are:

The lack of speed when it comes to obtaining project approvals
The fact that many of the locations for these projects are deficient in support infrastructure
The absence of sufficient tax incentives for developers of affordable housing
The unfriendly state of FDI processes in India
All these factors have played a role in discouraging more institutional funding into India’s affordable housing sector. Considering that the profit margins in this segment are inherently thin and become attractive only when a sizeable number of units in such projects are developed and sold, the cumulative challenges are not insignificant. Investing in affordable housing is a play on volumes, which means that it calls for large supply”(Affordable Housing In India – Current Status, Future Prospects, India Infoline ).
Dr.A.Jagadeesh Nellore(AP),India